5 vi CONTENTS 11 FISCAL POLICY: GOVERNMENT SPENDING AND TAXATION 181 What Fiscal Policy Is 182 The Effect of Spending 182 The Effect of Taxation 184 The Overall Effects of Spending and Taxation 188 Limits of an Active Fiscal Policy 189 The Effect on Aggregate Supply and Demand 189 Deficits: Do They Matter? 190 KNOW THE CONCEPTS 193 PRACTICAL APPLICATION 193 ANSWERS THE SUPPLY OF MONEY. 797 What Is Money? : 197 How Money Is Measured 198 The Federal Reserve 199 Balance Sheets and Banks: Federal and Commercial 200 How Money Is Created 201 How the Fed Controls the Money Supply 204 The Taylor Rule: What Does the Federal Reserve Do? 208 How the Fed Reacted to the Financial Crisis in KNOW THE CONCEPTS 212 PRACTICAL APPLICATION 212 ANSWERS MONEY AND AGGREGATE DEMAND 217 Money Demand 218 The Quantity Theory of Money 218 The Long-Run Neutrality of Money 220 How to Predict Inflation 223 The German Hyperinflation 224 The Short-Run Effects of Money: The Monetarist Model 224 Keynesian Model of the Short-Run Effects of Money 226 The Long-Run Effects of Money Supply on Interest Rates 229 The Spending Multiplier and Fiscal Policy 230 Bonds: Interest Rates and Prices 230 The Differences Between Keynesian and Monetarist Views 232 KNOW THE CONCEPTS 234 PRACTICAL APPLICATION 235 ANSWERS INFLATION AND UNEMPLOYMENT 247 What Causes the Short-Run Aggregate Supply Curve (AS) to Shift? 242 The Relationship Between the AS Curve and the Phillips Curve 244